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One of the key provisions of the chartering legislation would force the break-up of several of the largest U.S. corporations. Nader and his cohorts say that "a program of deconcentration is essential” to produce “lower prices, less waste, more innovation, greater variety of goods, and less centralized power". Actually, the conditions which they say breaking up those companies would produce are the very ones in which the companies excelled and caused them to attain their large size. The legislation would make size and share of the market "a presumption of illegal monopoly" and would set up an Anti-monopoly Court, whose rulings “would usually entail divestiture". It also would bar any federally chartered corporation from acquiring any company in any industry where four or less companies control 50% of the market.

In answer to the statement that the federal chartering legislation would lead to a federal takeover of business and to socialism, the Nader group declares that we have had federal chartering of banks without this result. The act establishing federal chartering for banks was not filled with the radical provisions for restructuring business and drastically altering the free enterprise system that are contained in the proposed legislation for federal chartering of corporations. The United States Industrial Council reiterates that, whatever Nader and his followers may say, the legislation they seek would lead to nationalization of private business and socialism in this country. We will oppose it with all the resources at our command.

STATEMENT OF JOHN R. PHILLIPS ON BEHALF OF THE CENTER FOR LAW IN THE

PUBLIC INTEREST

I. INTRODUCTION AND SUMMARY

My name is John R. Phillips. I am one of the founding attorneys of the Center for Law in the Public Interest, a nonprofit charitable corporation based in Los Angeles and governed by a prominent 30-member Board of Trustees. The Center is funded by charitable contributions (including foundation grants and membership dues) and court-awarded attorneys' fees.

The Center originally focused on environmental litigation but more recently has established a new litigation project on corporate responsibility. Our involvement in this new project has taken the form of three shareholders' lawsuits against corporations (Northrop Corporation, Phillips Petroleum Company and the Lockheed Corporation) which made illegal domestic political contributions and/or improper overseas payments. The Northrop and Phillips cases have been resolved through court-approved settlements, both of which involved major institutional and structural changes that will directly impact these companies and their shareholders in a positive way for years to come. The Lockheed litigation continues.

I would like to describe to this committee the background of these cases; the settlements and how they were achieved; what in our opinion are some serious structural deficiencies of most major American corporations; and, what role we believe Congress should play in attempting to rectify these structural weaknesses.

The Center's objective in commencing such litigation was to create a model of corporate structural reform that could be used by other boards of directors and other lawyers who are also engaged in various types of shareholder litigation. From the beginning, our aim was to implement many of the corporate reform proposals that scholars and business executives have written about over the last several years but have rarely implemented. We were assisted in this task by Melvin Eisenberg, professor of law at the University of California at Berkeley, who is a recognized national expert in the field of corporate law.

The settlements achieved in both the Northrop and Phillips cases were in sharp contrast to typical resolution of shareholder disputes in the past. In those disputes, the traditional remedy of money damages was the only remedy sought. While we felt that recoupment of corporate funds was an important objective, we believed that it did not go far enough and did not strike at the heart of the problem which gave rise to the litigation. These corporate cases provided a unique opportunity to use the rather strong bargaining leverage that we obtained through litigation to fundamentally alter the decision-making process of these corporations in a way that will benefit the corporations and its shareholders.

The litigation against Northrop Corporation and Phillips Petroleum Company brought to light common structural weaknesses. These created a climate of corporate isolation in which illegal acts could go unchallenged. It revealed that the boards of directors were essentially nonfunctional and ill-equipped to play their independent role of controlling and monitoring corporate management and formulating corporate policy. The institutional reforms implemented through the courtapproved settlements were designed to force these boards to become more aggressive and independent of management and to create a climate that would encourage enlightened decision-making which would take public policy implications into account.

The settlements required, among other things: 1) appointment of new independent outside directors jointly selected by the company and shareholder representatives; 2) a minimum (60%) of independent outside directors on each board ; 3) creation of audit and nominating committees composed solely of outside directors with independent staff if necessary ; 4) limitations on executive committees; 5) limitation or extraordinary disclosure requirements regarding expenditures on political activity; and 6) in the case of the Northrop Corporation, the selection of a new president.

To encourage corporations to voluntarily adopt similar measures, Congress should mandate the Securities and Exchange Commission ("SEC") to: develop a structural model for boards of directors of major corporations similar to that instituted in our Northrop and Phillips cases; require the board of directors of each corporation over a certain size to carefully file a written report (similar to an 8-K and 10-K) with the SEC stating whether they have adopted the various provisions as goals to be met within a certain timetable and, if not, the supporting reasons. Those corporations which do not adopt each proposal should be required to disclose annually to the shareholders and public in both the annual report and proxy materials that they have refused to adopt the recommended proposal of the SEC.

If there is minimal voluntary compliance, Congress may wish to enact federal chartering legislation that would require adoption of these proposals as a prerequisite for being granted a charter.

II. THE LITIGATION

At the outset, I would like to state that it was unusual for the Center to engage in shareholder litigation. We concluded that it was appropriate for us to file litigation against these three corporations because the shareholders' interest and the public interest appeared to be congruent. We fully recognized, however, that if these interests ever diverged, that it would be our ethical responsibility to represent the shareholders' interests as we perceived them. We did not perceive ourselves as public prosecutors.

It is instructive to analyze the factual background of litigation in both of these cases because it gives an insight into the rather limited role played by the Board of Directors in each instance.

The attitude of both corporations were quite different. Northrop went along with the proposed settlement with considerable reluctance; the Phillips Board, on the other hand, demonstrated a greater degree of open-mindedness and took a more farsighted approach in approving the settlement.

Northrop Corporation Litigation. The disclosures regarding Northrop Corporation's creation and maintenance of an illegal campaign fund that was generated through foreign transactions over a ten-year period came about quite by accident and not through the probing of its own Board of Directors. Herbert Kalmbach first testified in July, 1974 before the Senate Watergate Committee that he had received $75,000 in cash from Thomas Jones, the Chairman of the Board of Northrop. Following this testimony, Mr. Jones repeatedly and falsely represented to his own Board, the F.B.I., and the General Accounting Office that these were personal rather than corporate funds. Six months later, after an investigation by the Special Prosecutor and after Frank Lloyd, a top vice-president and director of Northrop, made it clear that he was going to answer truthfully all questions put to him by the Special Prosecutor, Jones finally admitted that the funds given to Kalmbach (which were apparently used to pay off the Watergate burglars and their families), and an additional $100,000 paid to the Nixon campaign, were corporate funds drawn from a secret cash fund generated through foreign transactions and that they were under the exclusive control of himself and his top lieutenant.

Mr. Jones and the company both pleaded guilty to felony violations of the Federal Elections Campaign Act. Immediately following that plea of guilty, the Board of Directors issued a statement that this was an abnormal departure

the normal high standards of conduct by the Northrop Corporation. The Board, after the lawsuit was filed several weeks following the guilty pleas, vigorously resisted all attempts of plaintiff's counsel to investigate thoroughly the facts underlying the contributions. It was only after the judge turned aside their attempts to block discovery that we had access to some rather startling information. We discovered the fact that these illegal contributions were not an abnormal departure but part of a pattern and practice that had gone on for over a ten-year period involving hundreds of thousands of dollars. In addition to these slush funds generated through foreign transactions and returned to this country for use in political campaigns, we also discovered the fact that millions of dollars of company money was paid to shadowy foreign consultants under the sole authorization of Mr. Jones.

Upon closely analyzing the decision-making process that put in motion these illegal acts, it became clear to us that this Board of Directors was not functioning as an effective Board at all. It was, in fact, totally dominated by Mr. Jones. As long as the corporation was making a healthy profit, the members of the Board of Directors played a most passive and inactive role. The Board was essentially a rubber stamp for Mr. Jones.

Our first demand upon which all other factors were contingent was that there be a full and completely independent investigation and disclosure of the facts and circumstances surrounding these revelations. To that end, we proposed an arrangement which required that an investigation be conducted by a newly constituted Executive Committee of the Board of Directors, four out of five of whom would be new directors brought onto the Board by a joint selection process between both the company and shareholder representatives with court approval. Special legal counsel assisted the Executive Committee in its investigation and preparation of a comprehensive report and submitted it along with recommendations to the full Board for its consideration. That report was completed within six months. In addition to sharply critizing the performance of Mr. Jones as Chief Executive Officer, it offered an insight into the failure of the style of management fostered by Mr. Jones that is not atypical of many major corporations. The Committee concluded that:

"Mr. Jones as Chief Executive Officer must bear a heavy share of the responsibility for the irregularities and improprieties noted in this report, for the atmosphere within Northrop which contributed to those shortcomings, and for the failure to concern himself with the functional weaknesses and pressures within management which have brought the company to its present circumstances. ... More generally, the Committee believes that Mr. Jones created within the company by his example and style of management, an atmosphere which discouraged informed discussion of the wisdom and practicality of various arrangements and practices that carried substantial business risks, as well as significant adverse legal consequences, for the company. Northrop and its shareholders are now confronted with the consequences of his actions."

The committee recommended that Mr. Jones step down as Chairman, which he did.

It is instructive to consider how the Board of Directors got into the position of allowing its Chairman to engage unchecked in such improper conduct. Mr. Jones became President in the early 1960's. He immediately centralized his control and isolated himself at the top. During the next decade Jones hand-picked Board members who were either his social or business contacts, which resulted in the Board becoming a rubber stamp. Hence their allegiance was more to Mr. Jones than to the shareholders and their willingness to support him, even when they did not know the facts, is an example of that blind allegiance.

He did not groom a successor. No one within the Company was in a position to assume the top position. This is undoubtedly the reason the Board has been forced to retain him in a top executive capacity. And, no one on the Board was asking the discerning questions. When the reports began coming out that there may have been some questionable activity engaged in by Mr. Jones, the Board ignored the warning signals and stood steadfastly behind him.

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1 The Committee report also stated : “The Executive Committee is not convinced that Mr. Jones has communicated fully and openly with the auditors, with the Committee and with the Board of Directors itself, or recognizes the seriousness of his involvement in the matters addressed by the Committee. The Committee is disappointed that Mr. Jones failed to concede his lack of knowledge regarding certain of the matters discussed in this report. The Committee also is concerned that Mr. Jones failed to acknowledge his familiarity with matters with which the Committee is persuaded that he knew or should have known." Report to the Board of Directors of Northrop Corporation on the Special Investigation of the Executive Committee, pp. 57–58.

Only when they were forced to face the harsh reality of his conduct because of the involvement of the Securities and Exchange Commission, Northrop's own outside auditors, its outside counsel and the shareholders' litigation did they begin to act.

The terms of the settlement we proposed that were ultimately agreed to by the Company were designed to open up the Board of Directors and break the stranglehold that Mr. Jones had on the company's decision-making. New institutional arrangements were proposed and accepted that would make the directors more accountable and therefore more responsive.

In addition to the requirement of an independent investigation, the following substantive terms presented in the form of bylaw revisions were approved by the court as a part of the settlement:

1. At least 60 percent of the Board of Directors must be composed of independent outside directors, requiring an addition of four new directors. (That term was expressly defined to eliminate anyone who has any significant financial ties to the company.)

2. The four new directors were to be selected jointly by shareholder representatives and the company and approved by the court.

3. Within 18 months, the company must select a new President, and Jr. Jones must relinquish that title. In compliance with this provisison Thomas Paine was selected as President by the company.

4. A new Executive Committee was established that would consist of five members, four of whom had to be independent outside directors.

5. A new Nominating Committee was established consisting solely of outside directors. The purpose of this committee is to select and present directly to shareholders the nominees who are proposed as Board members.

6. A new Audit Committee was established, also consisting solely of independent outside directors. This committee has the responsibility of selecting the auditors, overseeing the scope of the audit and developing various company regulations and guidelines to ensure compliance with strict financial controls.

7. Northrop Corporation must petition the Department of Defense and appropriate trade organizations for new rules and regulations to govern all defense contractors doing business in overseas markets.

8. A complete ban for at least a two-year period was to be imposed on all political contributions, even those that could be legally collected through various corporate committees. Such committees could only be reactivated after two years with shareholder approval.

9. The company was to implement new procedures for approving all contracts with consultants abroad.

10. Additional funds were to be paid back to the company by various individuals.

Phillips Petroleum Litigation.-Our approach to the Phillips Petroleum Company was quite similar to that of the Northrop Corporation.

The complaint was filed after the former Chairman of the Board, William Keeler, and the company pleaded guilty in December, 1973 to felony violations of the Federal Elections Campaign Act growing out of a $100,000 contribution to the Nixon campaign. Subsequent disclosures made by the company indicated that the practice had gone on for a ten-year period and that a political slush fund had again been generated through various foreign transactions and were not recorded on company books. Substantial contributions were made from this fund to political officeholders and candidates on the state and federal levels,

Phillips Petroleum Company, like Northrop, had been dominated over the years by the Chief Executive Officer. But, unlike Northrop where the Chairman maneuvered to put himself into the position of dominating influence over the Board, Phillips Petroleum had a history of Chief Executive Officer domination, Phillips Petroleum Company began as a wildcatt operation back in 1917 up into the present where it is today a $5 billion corporation with profits exceeding $400 million annually. For over forty years, two men ran the company as if it were their very own. They needed and requested little help from the Board of Directors which was made up largely of management personnel. While this tradition has been loosening up somewhat over the past several years, it is quite clear that the Board of Directors of Phillips Petroleum Company has never operated as though it were truly independent representative of shareholder interests. Indeed, until this lawsuit was brought, eight out of the eleven directors were full-time officers/employees of the company. This ar

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rangement, of course, is a contradiction in terms. It is impossible for such an insider-dominated Board to monitor management which involves, of course, monitoring itself. Such a Board can only be expected to operate as a management committee rather than independent representative of shareholder interest.

Almost all of the people who were implicated in the creation and maintenance of the political slush fund in a position of decision-making had left the company by the time the case was brought.

The approach of the Phillips Board of Directors in negotiating the settlement in this case was constructive. Direct negotations took place between the Center attorneys and the three outside members of the Board and its Chairman. Center attorneys presented terms quite similar to those previously described in the Northrop case, and we discussed each of them in great detail. Our position was quite clear: we could defend each of these terms from the standpoint of sound corporate policy, and we argued that it was in both the shareholders' and the company's interests to adopt them.

The attitude of these four company representatives was refreshingly open and direct. It was not the typical attitude of "how can we get out of this lawsuit with as little change as possible." Rather the representatives examined these proposed terms in light of broad shareholder interests. The Center's proposals were adopted after several months of negotiations which called for major restructuring of the Board of Directors similar to the lines previously described in the Northrop litigation. It called for an immediate change from a heavily dominated insider Board (8 out of 11) to a majority of independent outside directors, which necessitated the addition of six new independent outside directors jointly selected by both the shareholder representatives and the company. The director search process took approximately two months, and six highly qualified individuals were culled from a list of approximately 40 names. Both sides of the litigation were most gratified to find that those six people who were all on the priority list were all anxious and willing to serve on the Board and found it to be a unique opportunity and challenge.

It is clear that the settlement in the Phillips Petroleum case will have a dramatic impact on the affairs of that company for decades to come. In many ways it is the most significant non-financial event in the company's history. The Board of Directors for the first time will have a majority of outside members (moving up to 60% upon resignations) who will be actively involved in establishing policy and monitoring the performance of management, something that has never been done in the past. It will open up the process and bring to bear enlightened, diverse and sophisticated business judgment to deal with the critical social and financial issues that will confront the company for the rest of this century and beyond.

These two cases afforded a unique opportunity to impose institutional corporate reform measures on two major corporations that will serve as a model for other lawyers or corporations who wish to consider similar structural reforms of their own companies. However, it is unlikely that many cases like this will be presented that will provide the same leverage for achieving the same kind of reforms. The sad truth is that shareholder lawyers who bring these cases are frequently more interested in attorneys' fees rather than lasting and positive results for the corporation. And, shareholder proposals to other shareholders contained in proxy materials have been largely unsuccessful.

The question is thus presented : How can companies either be persuaded or be required to re-evaluate their present board structure and decision-making process with a view to creating greater accountability to shareholders and the public and achieving closer scrutiny of management's performance.

The weaknesses found in the Boards of the Phillips and Northrop corporations are typical of those found in many other corporations. Structural changes that were adopted as part of the settlement in both of those could be applied to most other major corporations.

Our experience in these two cases has taught us that if the Board is required by a mandated statement from either the Securities and Exchange Commission, Congress, or in the context of litigation to consider these issues, there is every reason to believe that many of them may be adopted. Such a requirement will give the present outside directors the opportunity to discuss the benefits from the standpoint of sound corporate policy. Once considered, they will find that the arguments supporting these changes and their implementation are extremely strong.

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